Delinquency Rate

How to Calculate Delinquency Rate

In the commercial real estate (CRE) market, the delinquency rate measures the percentage of borrowers that missed payment obligations.

Generally speaking, the delinquency rates serve as a reliable proxy for understanding the current conditions of the real estate market, which is closely tied to the state of the macroeconomy.

Therefore, a sudden rise in delinquencies is a valid cause for concern among industry practitioners, even among those without a vested interest in the real estate sector.

In simple terms, the CMBS delinquency rate estimates the total balance of CMBS loans that are overdue.

To calculate the delinquency rate, there are two pieces of information necessary:

1. Balance of Delinquent Loans
2. Balance of Total Loans Outstanding

With that said, the steps to calculate the delinquency rate are as follows:

• Step 1 ➝ Calculate the Balance of Delinquent Loans
• Step 2 ➝ Calculate the Total Balance of Loans Outstanding
• Step 3 ➝ Divide the Delinquent Balance by the Total Loan Balance
• Step 4 ➝ Multiply by 100 to Convert the Delinquency Rate into Percentage Form

Delinquency Rate Formula

The delinquency rate on CMBS loans is calculated by dividing the delinquent loan balance by the total outstanding CMBS balance.

Where:

• Delinquent Loan Balance ➝ The balance of loans that have missed a payment deadline.
• Total Outstanding Loan Balance ➝ The total balance of all outstanding loans.

Conversely, the delinquency rate can be determined using the number of delinquent loans and total outstanding loans.

Where:

• Delinquent Loans ➝ The number of loans where the borrower has missed a payment deadline.
• Total Outstanding Loans➝ The total number of all outstanding loans in a portfolio or on a macro-level.

How Do CMBS Delinquencies Work?

Commercial mortgage backed securities (CMBS) are collateralized loans by a collection of commercial mortgages, and the underlying properties.

The risk profile of the properties tied to a CMBS loan can carry a wide variance, as the property types can range from office buildings to shopping centers.

The process of a CMBS collapsing into delinquency is conceptually comparable to any sort of default on a loan or debt security — but there is a distinction between the delinquency rate and default rate.

• Delinquency Rate ➝ The borrower is behind schedule and might have missed a payment but can potentially recover (and avoid property foreclosure).
• Default Rate ➝ The borrower has missed mandatory payments and is unable to meet a mandatory payment obligation owed to the lender on time, causing foreclosure to soon ensue.

CMBS delinquencies are more complicated than a default on a traditional commercial loan because there tends to be more moving pieces and stakeholders involved.

The lenders incur a monetary loss, or at least are placed at risk, but the other stakeholders, namely the investors in the CMBS, are impacted too.

In the worst case scenario, the failure to meet the payment deadline in a timely manner coincides with the inevitable foreclosure of the underlying property, causing stakeholders to incur steep monetary losses.

The distributable proceeds are often not enough for all stakeholders to be made-whole from the failure to recoup the loan’s entire value. But the risk-return trade-off is understood by most investors beforehand (i.e. the potential upside must have been deemed worth undertaking the risk).

• Diversification ➝ The appeal of CMBS loans is the diversification of the risk, wherein the risk is “spread” across several loans (and each investor can decide where to put their capital based on their risk-return profile).
• Pecking Order ➝ The drawback to the CMBS loan structure, however, is that delinquencies can have broad implications and cause several stakeholders to sustain losses, albeit certain investors are more protected than others (i.e. senior tranche).

CMBS Delinquency Rate by Sector

The delinquency rates for office and industrial property CMBS loans surged during the COVID-19 pandemic as offices shifted to remote work (or hybrid model), while industrial facilities grappled with supply chain disruptions.

In short, the higher interest rate environment, an uncertain economic outlook, and shift toward remote work placed substantial pressure on the office sector.

The Fed’s decision to raise interest rates, or the cost of borrowing, made matters worse, as the entire commercial real estate (CRE) sector faced headwinds — illustrating the influence that macro risk and external events can have on these sorts of complex financial securities.

General Rules of Thumb:

• Industrial ➝ The industrial sector has historically demonstrated resilience, with one of the core drivers being the growth in e-commerce, creating more demand for warehouse and distribution facilities.
• Hospitality and Lodging ➝ The hospitality and lodging sector has experienced significant volatility and is influenced by travel restrictions and shifts in consumer behavior resulting from unforeseeable events like the COVID-19 pandemic.
• Multifamily ➝ The multifamily sector remains relatively stable, namely because a home and housing properties are necessities rather than a discretionary asset.
• Office ➝ The office sector encounters obstacles due to shifting work patterns in the modern workplace, most notably the normalization of remote work.
• Retail ➝ The retail sector has been severely compressed in recent times, particularly shopping malls and physical stores, as a result of the surge in online shopping and evolving consumer preferences, although the trend has started to recover in a favorable direction.

^{CMBS Loan Delinquency Rate Data (Source: Moody’s Analytics)}

CMBS Delinquency Status Terms